The advice offered by some of its leading thinkers that Labour should switch the focus away from the role of central government and towards a greater devolution of power to the regions and communities has a fashionable ring to it. But it is another, perhaps unwitting, admission of the left’s damaging loss of intellectual self-confidence.

There is, of course, much to be said for bringing the exercise of power closer to the people; but the difficulty lies with its corollary – that expectations of what can be achieved by government should be reduced.

A reduced role for government is, after all, an essentially right-wing – and, in modern terms, neo-liberal – preoccupation. It was Ronald Reagan who famously claimed that government was the problem and not the solution; and since then, the political right has worked hard to scale down, and in many cases remove, any power claimed by government to intervene in the “free market” economy.

The left, by contrast, has traditionally and valuably seen government, particularly when its role is legitimised by democratic election, as a necessary bulwark to protect basic freedoms and an essential defence for the interests of ordinary people against the otherwise overwhelming power of those who would dominate the market place.

The shift in power away from democratically elected governments and in favour of large corporations, greatly aided as it has been by globalisation and the acceptance of neo-liberal economic doctrines, is after all already well advanced – which makes it all the more surprising that influential voices from the left should recommend that it should be further encouraged rather than resisted.

It is one of the main indictments of New Labour that it showed itself to be so welcoming of the notion that government’s duty was to put business interests first – and it seems that the lessons to be drawn from that experience have still not been learnt.

Not only do we live in a society where all values are increasingly subordinated to the bottom line, but we run an economy in which all the major decisions have been removed from democratic government and handed over to institutions which owe no loyalty to anything other than the profits to be made for their shareholders from – as the Bank of England acknowledged last week – an astonishing monopoly power to create huge volumes of new money. Virtually all the important economic decisions are now made, not by a government accountable to the voters, but by banks accountable only to their shareholders.

The craven attempt by politicians to hand over responsibility for economic management has a lengthening history. The Exchange Rate Mechanism, the European Monetary System and the Euro – to say nothing of setting up an “independent” Bank of England to decide monetary policy – have all been devices to allow politicians to escape being held to account. It is disappointing to find voices on the left advocating a further extension of this cowardly disclaimer.

That disappointment is further compounded by the apparent failure to understand that fragmenting, localising and under-resourcing interests opposed to those of the business big battalions is a recipe for clearing the way for yet further domination by those powerful interests. The only chance we have of countering the ever-growing power of international capital is to summon up, coordinate and combine the total potential power of government – all the resources potentially at its command and all the legitimacy that is derived from the ballot box.

For the left to turn its back on this obvious truth is a painful – and totally unnecessary – dereliction of duty and counsel of despair. Are we really ready to concede – as George Osborne asserts – that there is no alternative to the current destructiveness of austerity, and therefore no role for a government taking a different view and pursuing a different policy?

Are we really saying that voters need not and should not look to a Labour government for a society that is fairer and more caring – a better society that is necessarily based on a better-performing economy?

Do we concede that a better-performing economy is beyond the capacity of a Labour government? Are we so lacking in intellectual curiosity and ambition that we are unaware of, and unwilling to pursue, the increasingly accepted possibilities of a quite different approach to macro-economic policy? Do we really have nothing to say on these central issues, but are instead content to linger in the foothills so as to divert attention away from the need to scale the challenging peaks?

Why not do some hard work on the central issues facing this country- and in particular on a different macro-economic policy – and then have the courage and confidence to say to the electorate that changing government will make a real and beneficial difference to the lives of most people. If we don’t believe that, why should anyone else?

The global financial crisis, when it broke in 2008, seemed likely to mark a conclusive end to the neo-liberal hegemony that had dominated world politics and the global economy for more than three decades. Yet, to the consternation of those who were ready to welcome such a denouement, the immediate reaction of popular opinion in many western countries was to “hold on to nurse”; ordinary voters sought refuge in what they knew – or had been taught to believe.

It is only gradually – and recently – that faith in the hitherto prevailing orthodoxies has begun to weaken. There is now quite discernibly a flagging confidence in the infallible and self-correcting market, in the rationale that tries to justify huge rewards for a tiny minority, in the trustworthiness of bankers, and even in austerity as the correct response to recession.

As a consequence, “the left” is gradually rediscovering its intellectual self-confidence, and beginning to look to a post-neo-liberal world; the timidity of New Labour is being replaced by an increased readiness to engage afresh in the battle of ideas. But while all kinds of ideas are being either revived or newly developed, and there is a renewed emphasis on and confidence in the role of social and environmental policy, there remains one hugely significant “no-go” area. There is a striking unwillingness to tackle the central issues of economic policy.

It was significant, for example, that, in the seven issues that Tony Blair, in his New Statesman article, advised Ed Miliband to focus on, there was no mention of the state of the economy. We should not perhaps be surprised, since Tony never had much interest in or knowledge of economic policy – and he is not, of course, alone among leading left politicians in disavowing any interest in economic affairs. The sad truth is that most have simply assumed, like Tony, that economics is a difficult and technical business that can safely be left to the bankers, and is therefore no longer their responsibility.

They tell themselves that the economic process is probably immutable anyway, and that the real business of politics is in any case about other easier and more emotive issues. Most are content to accept advice from supposed experts, which usually means that they have no option but to go along with whatever may be the prevailing orthodoxy. Even a Gordon Brown – who was widely thought for a time to be a master of economic policy – can now be seen to have been merely a prisoner of his orthodox advisers.

The dead hand of long-established orthodoxy continues to weigh down on the current Labour leadership. Even Eds Miliband and Balls, who clearly have some understanding of what is needed, find themselves constrained by the fear that anything too overt by way of new thinking will open them up to damaging attack. They have to move cautiously; and that inhibits them from developing and advancing a fully comprehensive and coherent alternative policy.

Yet the issue of how the economy should be run, and in whose interests, is surely the central issue in democratic politics. Advances in approach and policy on other issues will count for little if the central tenets of neo-liberalism are allowed to remain dominant in the way our economy is run. If the left wants to engage in meaningful debate on the questions that truly matter and to make a real bid for power, it cannot avoid the essential features of economic policy , and it cannot expect to carry the day just by taking occasional potshots at George Osborne. That is too easily deflected with the demand “what would you do?”; and if the answers are merely occasional hostages to fortune offered up without being established in a context that is coherent, comprehensive and compelling, then that whole, centrally important territory is necessarily conceded.

What would such a context look like? It would have to do more than provide an intellectually convincing critique of neo-liberal orthodoxy, though it might take that as its starting point; it would have to offer a complete alternative strategy that made sense and held together in economic terms and was credibly able to promise better results than what had gone before.

There should, in my view, be five elements in an economic policy that marked a real change from the failed neo-liberal nostrums. They are a focus on competitiveness, credit creation for productive purposes, an agreed industrial strategy to rebuild the productive base, restoring macro-economy policy as the central responsibility of democratically accountable governments, and, above all, making full employment the central goal of policy. Let us look at each of those in turn.

Competitiveness

The competitiveness of British industry, or lack of it, has of course been the great taboo of our economic policy for decades. It is almost totally ignored and virtually never discussed. Though various indices of competitiveness are maintained, they are never referred to and are apparently regarded as irrelevant to any consideration of the course our economic decision-making should take.

When Alastair Darling published his 300-page account[i] of his term as Chancellor of the Exchequer, there was not a single reference to competitiveness as an issue or to its concomitant, the exchange rate. As I know from my own experience as a young backbench MP in the 1970s, it was extraordinarily difficult even to table parliamentary questions on the subject of exchange rate policy which was regarded as too sensitive to be discussed.

Yet a moment’s thought should tell us that, in a post-war world that has seen the rapid industrialisation of new economic powers, including the rise of the world’s second largest economy in a remarkably short time, it would be extraordinary if the UK could simply assume that our place in the competitiveness stakes could remain unchanged without any care or attention being paid to it by our policymakers.

It is of course not quite true that the issue has not been the subject of intervention; our position on the exchange rate for sterling has always been that any depreciation should be resisted. This has been one of the cardinal, but unstated, features of our economic policy and is one of the most important consequences of allowing the requirements of the financial economy to take precedence over the real economy, and of accepting that monetarism is the only correct basis of a sensible economic policy.

This distortion of policy has a long and sad history. As long ago as 1925, Winston Churchill famously observed, as Chancellor of the Exchequer, that he would rather see “Finance less proud and Industry more content”. In more recent times, Denis Healey, having exhausted the reserves in defence of sterling in 1976, rejected the IMF advice that monetary policy should be framed in terms of Domestic Credit Expansion (DCE) – an open invitation to grow the economy on the basis of a lower exchange rate and export-led growth – and preferred instead to adopt monetarist orthodoxy and the defence of sterling as the key features of his Chancellorship.

At that same time, Jim Callaghan as Prime Minister told the Labour Conference that “you can’t spend your way out of recession” – a nonsense then as it is now. What he was really trying to say was that “we dare not try to escape from stagflation by stimulating the economy, because growth would inevitably create insuperable problems of rising inflation and worsening trade deficits.” The problem he was really grappling with, in other words, was not the failure of Keynesian economics, but a catastrophic, though unacknowledged, loss of competitiveness.

That issue remains at the heart of our economic problems today. Austerity is regarded, at least in government quarters, as our only possible policy option, because it is accepted that to try to grow our way out of recession would be to expose the fact that we no longer have the productive base to allow us to do so.

The parlous state of that manufacturing base, and the disastrous reliance placed on a financial services sector that – even at best – brought benefits to only a small part of the population, are only the most recent outcomes of a policy that has for decades preferred to avert its gaze from the truth of our situation. A loss of competitiveness will be felt most directly in the highly competitive international markets for mass-produced manufactured goods, and that has been exactly our experience. This resolute refusal to address the issue of competitiveness is in marked contrast to the policies pursued by other, more successful economies.

Those economies that have grown rapidly over recent decades have taken a quite different approach. The new economic giants of Asia, for example, have focused on trying to hold down their exchange rates so as to maintain the competitive advantage that rapid industrialisation – with its consequent economies of scale, quick returns on investment, and high profits to be re-invested – is able to produce. China, in particular, has clearly recognised the importance of holding down the value of the renminbi over the whole period of its rapid growth, while Japan, intent on kick-starting a sluggish economy, is taking decisive action to bring down the value of the yen.

An economy like Singapore, with an economic performance to its credit that puts us to shame, has quite specifically focused on competitiveness as the central indicator of the efficacy of its policies. And Germany, Europe’s most successful economy and exporter, pays constant attention to competitiveness indices, such as unit costs in manufacturing, export prices and measures of productivity growth.

Despite this persuasive evidence that other more successful economies may know something we don’t, we choose to pay the issue no attention. We have been brought up for generations in the belief that manipulating the currency (other than upwards) is somehow morally shameful and – in accordance with all good morality tales – will in the end do no good. It is an article of faith – never examined in the light of actual evidence – that a devaluation will quickly be eroded by inflation and will make little difference to economic performance.

My co-author on an earlier occasion[ii], John Mills, has however recently examined the statistical evidence in respect of twenty devaluations in different countries and at different times.[iii] He is able conclusively to disprove the contentions that devaluation is negated by inflation and that it does not help living standards to rise. It should come as no surprise to most people, and especially to those who recognise the market’s alacrity in responding to stimuli, that reducing prices in the international marketplace will stimulate sales, and that increased sales and profitability will produce greater investment and employment to the advantage of the economy as a whole.

But, it may be objected, if the exchange rate is so important, surely the recent depreciation of sterling should have stimulated the economy? Yet we are still bumping along at a couple of percentage points below the 2008 GDP peak. Does this not show that devaluation is not a panacea and cannot be relied on to change our fortunes?

Let us first make the point that the depreciation of recent times is typical of our experience of devaluation; it has been an ex post facto response to an increasingly intolerable loss of competitiveness, and is the minimum required just to keep us in business. It is far from a considered attempt to achieve a desired level of competitiveness of the kind that our successful competitors take for granted as the sine qua non for export success.

But let us also concede that a competitive exchange rate is a necessary but not sufficient condition for export-led growth. Without it, nothing else will be effective to bring recession to an end and to make up the ground we have lost. But with it, there is then good reason to look to other measures that would at least then have a good chance of working.

Credit Creation for Productive Investment

The most important of such measures is my second major issue – the provision of sufficient credit for investment purposes. We have grown so accustomed, after nearly four decades of monetarism, to regarding control of the money supply as an essential weapon in the battle against inflation, that we have lost sight of its true significance. The monetarist approach takes a narrowly focused, backward-looking and static view of the economy; it treats monetary policy as though it were a minefield, and any growth in the money supply as a dangerous beast that must be kept strictly muzzled and leashed.

The consequence is that monetarism has become a recipe for slow growth and high unemployment. It allows little account to be taken of the potential for a market economy to grow – surprisingly, since the proponents of monetarism are the most committed self-proclaimed supporters of the “free” market. As soon as there is any sign of growth, an almost superstitious fear of inflation (which is almost always code for a rise in wage levels) dictates that demand must be choked off and job growth restrained.

The only mechanism available to undertake the task of controlling the money supply is the manipulation of interest rates, so that, in addition to the intrinsically anti-growth stance dictated by the policy, the cost of borrowing for investment is forced up and becomes a further barrier to improved competitiveness. Higher interest rates, and the consequently high exchange rate, are a poorly focused and slow-acting counter-inflationary instrument that produce a good deal of collateral damage while addressing a problem that in recessionary times is hardly the top priority. The limitations of interest rates as a tool of macro-economic policy can be clearly seen in the unsuccessful current attempt to use lower interest rates as a stimulus to an economy mired in recession; without help from other elements of policy, bringing down interest rates is, as Keynes observed, like pushing on a piece of string.

The preoccupations of monetarist policy with restraint and fighting inflation are all the more remarkable when we consider what really happens in the real world beyond monetarist theory. In this world, there is little concern about monetary growth and no attempt to restrain it. The size of and growth in the supply of money is almost entirely within the control of the commercial banks. Their interest is to lend as much as possible, and they do so, constrained only by their own need for security if irresponsible lending goes wrong, and totally unconcerned about the effect any growth in the money supply might have on the economy as a whole. No one else seems to notice this, let alone do anything to restrain it.

The consequence is that, in an economy that is in principle run on the basis of strict control over the money supply, there is virtually a private sector free-for-all. Bank lending (or, as we should say, bank credit creation) accounts for by far the overwhelming proportion of money and monetary growth in the economy and – significantly – is mainly devoted to lending secured by property, which means in most cases, residential properties which are the most reliable and easily realised form of security. This is not only damaging in itself, not least in the stimulus it provides to inflation, but it also diverts investment capital away from productive purposes.

These barely recognised characteristics of what passes for macro-economic policy are in marked contrast to the approach taken at other times and in other countries. We have focused for so long on restraint and protecting the value of existing assets rather than creating new wealth that we are simply unfamiliar with the thinking that has enabled other economies to use monetary policy and credit creation for productive purposes as essential elements in boosting economic performance.

History provides compelling evidence to support Keynes’ pre-war contention that “there are no intrinsic reasons for the scarcity of capital.”[iv] Two of the most striking instances of how credit creation was used, not to inflate the property market for private profit, but to stimulate rapid industrial growth, were the United States at the outbreak of the Second World War, when Roosevelt used the two years before Pearl Harbour to provide virtually unlimited capital to American industry so that the country could rapidly multiply its military capability, and Japan in the 1960s and 1970s, when Japanese industry was enabled by similar means to grow at a rapid rate so as to dominate the world market for mass-produced manufactured goods.

More recently, China has used similar techniques to finance the rapid expansion of Chinese manufacturing. The Chinese central bank, under instructions from the government, makes credit available to Chinese enterprises that can demonstrate their ability to comply with the government’s economic priorities. This is admittedly, in principle at least, easier to bring about in a totalitarian regime than in the UK, but in practice there is nothing to stop the government from requiring the Bank of England to create credit (at no cost) for specific purposes.

Indeed, the Bank of England has already undertaken quantitative easing on a significant scale. The difference between that exercise and what is now required is that the quantitative easing so far undertaken has been used for the purpose of shoring up the banks’ balance sheets, whereas an effective creation of credit for investment purposes would be applied directly to the strengthening of our productive base.

The rationale underpinning this strategy is a simple one. Whereas a sudden expansion in the money supply would, according to monetarist theory, feed directly into increased inflation, that would be true only when the economy is already fully utilising its productive capacity. As we have seen, it is all too easy to assume, and it usually is assumed by monetarist theorists, that there are strict limits to that capacity – an assumption that is all too likely to be validated by the anti-growth bias of monetarist policy – and, again as we have seen, it is unfortunately true of an economy that is fundamentally uncompetitive.

But where an economy is manifestly operating at less than full capacity, there is no point in restricting the money supply – especially in the matter of capital for investment. What is needed in a recession is a lift in demand so that markets at home expand, coupled with an improvement in competitiveness so that exports are encouraged. In these circumstances, a deliberate policy of investment credit creation would bring the double benefit of providing readily available finance to support productive investment and to rebuild a sadly weakened manufacturing base, and at the same time encouraging a fall in the value of sterling as the foreign exchange markets recognised that this was a deliberate aspect of the policy; these are, after all, key features of the strategy now being pursued by Shinzo Abe’s government in Japan and are justified – and largely accepted by Japan’s trading partners – on the basis that everyone will benefit from a more buoyant Japanese economy.

Monetarist fears that any increase in the money supply will lead straight to an unacceptable inflation have in any case already been disproved by the experience of several countries with quantitative easing, and, on the contrary, is essential if we are to escape from what Paul Krugman calls the “liquidity trap”. It is even less of a threat when the monetary expansion takes the form of capital invested in new productive capacity. As Keynes argued, credit creation for such a purpose will not be inflationary if it results in increased output.

An Agreed Industrial Strategy

This means that this second essential element in an effective economic policy is, of course, dependent for its effectiveness on the third element – the development of an agreed industrial strategy. This does not raise problems for a centrally directed economy such as China, nor is it a difficult issue in wartime when the needs are pretty obvious; and, while a country like democratic Japan, with its more structured society, might find that the common good might be more readily accepted as the basis for action than it would be in the West, the greater scope for debate on what shape it might take in peacetime and in a western country like the UK should not mean that it is any more difficult in principle.

An effective industrial strategy for Britain would require agreement and support from each of government, industry and the banking sector. But the task is not an impossible one; the urgency of what is required should surely concentrate minds. The strategy need not “pick winners” in detail or operate in too prescriptive a manner but would establish criteria and measures of performance that would provide a context within which the normal processes for identifying worthwhile investment opportunities could operate so that a great deal of the decision-making could be left to the usual agencies.

Proponents of the current orthodoxy will of course argue that to attempt such an exercise would be to usurp what is the proper role of the market. But that is to ignore two obvious factors – the current failure of the market to produce satisfactory outcomes and the successful experience at other times and of other economies with just such a strategy.

A successful industrial strategy would, of course, focus on manufacturing. It is a competitive manufacturing sector that has underpinned the growth of other economies by providing access to mass markets and economies of scale. It is manufacturing that uniquely provides the stimulus to innovation, the quick return on investment, the development of new skills and the creation of new jobs – all elements in a successful economy that have sadly eluded us over a very long time. It is manufacturing that makes possible the strategy of investment credit creation by offering a sufficient return on that investment in terms of increased output so as to provide the virtuous circle of increased investment leading to increased output and back again to yet greater investment that has served other economies so well.

Restoring Macro-economic Policy to Democratic Control

The commitment of government, industry leaders and the banks to the development of such a strategy – encouraging its development, in other words, as the outcome of a wide-ranging consultation so that it thereby gains considerable popular support and understanding -would point the way to a further essential reform which constitutes the fourth element in a successful economic policy – the restoration of macroeconomic policy to its proper place as the responsibility of government.

The elevation of a supposedly “independent” central bank to the role of unchallengeable arbiter of macro-economic policy was widely applauded when Gordon Brown introduced it and is still virtually never questioned. It can hardly be argued, however, that it has produced successful results; and there is now at least a greater disposition to ask whether bankers are as objective and free from self-interestedness as was thought.

The evidence is that handing monetary policy over to the tender care of a central bank is simply a reinforcement of the current and increasingly discredited orthodoxy that inflation is the only concern and proper focus of monetary policy and that its treatment is simply a technical matter that is properly the preserve of unaccountable bankers, and is not to be trusted to unreliable politicians. Quite apart from the undemocratic nature of this approach, whereby the most important decisions in economic policy-making are removed from the democratic arena, we have paid a heavy economic price for allowing the bankers’ interest to prevail over the interests of the economy as a whole.

It is easy to see why the bankers – and the economists who increasingly work for them – should support this. It is less easy to see why the politicians should so readily have accepted it. Yet the answer is fairly clear. It has suited the politicians well to be able to argue that the travails of the economy arise, not by virtue of their mistakes or deficiencies, but as a consequence of inexorable economic forces which must kept in check and marshalled by expert technicians. In this way, our governments have been able to disclaim any responsibility for policies (and their consequences) for which they are ultimately responsible.

An economic policy that broke the shackles of current orthodoxy would necessarily have to be removed from the exclusive and self-interested control of bankers. It would need to be driven by politicians who saw the need to ensure that the wider interest is carried into policy and is an essential element in setting its direction and gaining for it the necessary support.

The aim should be to re-establish the full range and purpose of macro-economic policy. It would no longer be a simple matter of tasking the central bank with restraining inflation and then allowing market forces to get on with it. Other important outcomes – full employment, a reasonable and sustainable rate of growth, properly funded public services, and so on – would come back into the reckoning as the legitimate goals of policy. Governments would expect then to be judged on their success or otherwise in achieving those goals of a more broadly based economic policy. The outcome of reviving the public debate about macro-economic policy – a debate that has been in limbo for decades – would be not only a better performing economy and a more integrated society, but also a more vibrant democracy, as voters realised that their views might count after all.

Full Employment

As we have seen, an important benefit from a renewed debate about economic policy would be the possibility of replacing ideologically driven preoccupations, such as preserving the value of assets, reducing the size of government, and relying on austerity to escape recession, with goals that more accurately reflect the wider interest and represent a more comprehensive measure of economic success. Prime amongst such goals would be full employment – the fifth element in a more effective economic policy.

Full employment as the central goal of policy would not only be the most important step that could be taken to relieve poverty and to reverse the destructive growth in inequality; it would also be a huge step towards a more inclusive and therefore more successful economy. There is, after all, nothing economically efficient about keeping large numbers out of work and unwillingly dependent on benefits. Full employment is the hallmark of a properly functioning economy. An economy that was competitive in the sense that it could find profitable markets for its produce, and for which investment capital was available to finance increased production, would be able to use the productive capacity of its total workforce. Conversely, a high or persistent rate of unemployment shows that those conditions do not apply.

To restore full employment as the central goal of policy and as the measure of that policy’s success would revolutionise the way in which management of the economy is regarded. Once it was accepted that full employment is achievable, the success or otherwise of economic policy would be judged according to a criterion that was easily understood by the public. The value, in both economic and social terms, of the contribution that labour makes to society’s well-being would be newly acknowledged. Full employment would be seen as determining the direction of economic policy but requiring that other aspects of policy should also help towards this desirable outcome. It would be seen as important that the workforce was properly supported, through measures like comprehensive rights at work and appropriate skill training, and that the underlying services that guarantee the health and educational levels of the workforce were raised to a high level. The well-being and effectiveness of that workforce are, after all, our greatest asset.

This would represent, of course, a significant move away from the current orthodoxy which regards labour as just another production cost, to be kept always as low as possible. That approach may or more likely may not make sense from the viewpoint of the individual business, but it is certainly and literally counter-productive from the viewpoint of the economy as a whole. A change in approach would also run counter to the current, but usually unstated, belief that wage costs are too high and that the key to improving competitiveness is to drive them down – not least by allowing unemployment to remain high.

Conclusion

These five elements of an economic strategy to replace neo-liberalism would certainly represent a clear break from the orthodoxy that has dominated the world economy for so long. It has the merit of offering a real choice to the voters and enthusing those who are keen for change, without departing in any way from mainstream economics. The overall strategy is recognisably Keynesian and would be supported by that growing group of economists that is now confident that neo-liberalism as an economic doctrine has had its day.

It allows a coherent critique to be made of an orthodoxy that is manifestly failing, not only in the UK but in Europe and elsewhere – an orthodoxy that uses austerity to drive us deeper into recession and is increasingly defended not on its own merits but by the schoolboy tactic of demanding sight of an alternative. Each of the five elements in my proposed strategy supports the others and helps to create a coherent whole; objections to the relevance or practicality of one element can be met by pointing to the supporting role of the others.

Most importantly, it means that those who increasingly highlight the failures of neo-liberalism are not denied a political victory by their reluctance to tackle this malign doctrine on the centrally important territory where its deficiencies are most apparent and damaging. An economic strategy built on these elements would not only produce a better economic performance but would commend itself to the electorate as well.

Bryan Gould

4 May 2013

[i] Back from the Brink: 1,000 Days at Number 11, Atlantic Books, 2011

Stewart Wood in this week’s Guardian is right to argue that the paradoxical popular support for George Osborne’s manifestly failing policies for recovery should not mean that Labour must abandon its social democratic approach to solving the nation’s problems.

The drive for “responsible capitalism” is of course an important aspect of such an approach, and is an area in which Labour should expect to carry greater credibility than its right-wing opponents. But focusing on that issue concedes far too much to an orthodoxy which has served us so poorly.

Why does Labour, in addition to looking for greater responsibility from our business leaders, not espouse as well “productive capitalism” or “efficient capitalism” – in other words, a market economy that actually works? We are now into a fourth decade of Labour failure to mount any effective critique of monetarist orthodoxy, with the result that the whole area of macro-economic policy has been effectively conceded to our opponents. Yet, if ever there was an open goal, this is it.

The monetarist approach to economic policy asserts that the only goal of policy should be the control of inflation – something that can safely be left to bankers armed with the single instrument of interest rates – and that otherwise the market, if left to its own devices, will deliver optimum results. Government should just let business get on with it.

How well has this doctrine prepared us to face the challenges of a new world economic order in which China and India, Korea and Brazil, are making the running? The answer is that it has served us appallingly. We have continued our inexorable decline in the world pecking order – whether it be in our share of world trade, in the output of our manufacturing industry, or in comparative living standards. We do not recognise this only because we have become enured to long-term failure.

And that failure has culminated, of course, in the global financial crisis and a threatened double-dip recession which have left this country flat on its back and apparently facing up to a decade of austerity, no growth and further decline.

What response has Labour made to these startling failures? Nothing – other than deservedly attracting a share of the blame. Far from pointing out the nakedness of “free-market” monetarism, Labour has joined in the acclamation for the emperor’s finery, pinning its hopes when in government on the exploits of the City of London, and only narrowly avoiding the euro trap in which the ECB applies a ruthless monetarism even more extreme than the domestic variety.

It beggars belief that – now in opposition – Labour still finds itself unable to develop its own economic policy. Far from developing a coherent critique of more than three decades of right-wing economic failure, Labour is still urged by many, even in its own ranks, to ape the Tories – to be ‘realistic’, to put forward its own alternative austerity programme, and to accept that there is nothing for it but to accept the monetarist framework.

But for Labour to do so is to accept defeat. If the political argument is only about the degree of austerity, it is an argument Labour cannot win. The Tories will always be seen as more credible exponents of such policies.

Nor can Labour expect to be taken seriously if – while not challenging the imperatives of monetarist policy – it simply proclaims its readiness to take on more debt so as to spend our way out of recession.

Yet the intellectual straitjacket embraced by Labour is easily discarded. One of the prime weaknesses of the monetarist approach has been that, by identifying inflation as the over-riding – indeed, only – focus of policy, and by adopting monetary measures to combat it, we have made inevitable a literally counter-productive upward pressure on our exchange rate – and this at a time when our competitiveness in world markets was already under extreme pressure from the rise of new economic (and particularly manufacturing) super-powers.

We tried to escape the consequences of this loss of competitiveness by pinning our hopes on the international asset and credit bubble created by the City – and when that bubble burst, we discovered that we had a much-weakened real economy to fall back on.

It is competitiveness, not inflation, that is our central economic problem. Until we deal with it, any attempt to expand our economy will run up against a balance of trade brick wall. There will then be no alternative but austerity which, through a lower tax take from a lower level of economic activity, will simply make our debt problems worse.

We have suffered for decades from a blind spot about the exchange rate. Yet it is the key to improving competitiveness. We have reluctantly agreed in the past to devalue only as the remedy for a loss of competitiveness that can no longer be ignored – yet the exchange rate is the most effective, quick-acting, and comprehensive means of establishing an improved competitiveness for the future that would make short-term sacrifices fair to all, while establishing a base from which we can quickly build a strong British manufacturing economy that enables us to break free from recessionary shackles and to find a route out of the austerity cul-de-sac.

Isn’t that preferable to the stark lack of choice we now face? Why can Labour not find the courage for some new thinking?

Alan Bollard is a big man – well over six feet [around 1.9 m?] tall – but even his shoulders are not broad enough to bear the burdens placed on them. To point this out is not so much to criticise the Reserve Bank Governor as to lament the role in which he is cast.

He is, after all, lumbered with virtually the sole responsibility for what passes in this country for macro-economic policy. He alone must decide every six weeks on the direction in which monetary policy should be taken. He is given a single instrument – interest rates – and a single target – inflation.

Beyond that, macro-economic policy is virtually non-existent. Little matter that inflation might be low on the list of economic policy concerns, or that cutting interest rates might make little difference to anyone in an economy mired in recession. Faced with our manifold problems, the Governor- with his tiny armoury of largely irrelevant and ineffectual weapons – is on his own.

Little wonder then that – in deciding last week what to do about interest rates – he should have opted to share the responsibility by talking to the Minister of Finance. There was after all the small matter of continuing recession, with little sign of the much-touted recovery – and on top of that, the further blow of the 22nd of February Christchurch earthquake.

There was, however, much tut-tutting that the Governor should have opted, by consulting with his political masters, to depart from the principle of absolute independence for the Reserve Bank. Many commentators and practitioners seemed discomforted by the thought that the elected government might be asked to bear some responsibility for the fortunes of our economy.

The doctrine that macro-economic policy is a simple matter of setting interest rates – a task entrusted exclusively to the Reserve Bank – is of course greatly convenient for government. It means, in our current situation, that they can disclaim responsibility for a recession that is now well into a fourth year. Not only is it nothing to do with them but – according to the doctrine – anything they might try to do would be counter-productive.

The paradox is that governments that are unwilling to intervene in macro-economic policy, on the ground that the economy is best left to look after itself, are likely to end up being more interventionist than they expect. As the economy languishes because macro-economic policy settings are inappropriate, governments typically resort more and more – and with greater and greater desperation – to micro-economic intervention of various kinds.

So, we find more and more fiddling with tax rates and labour laws, more and more target-setting and micro-management for science and research and the delivery of education at all levels, tighter and tighter limits on benefits and public spending programmes – all in an increasingly futile drive to reverse our poor productivity and declining competitiveness.

But, surely, it will be asked, the Governor’s interest rate cut was a step in the right direction? Well, yes, it had a certain value as a psychological boost and as a small benefit to those with mortgages – but it is hardly likely to stimulate spending and investment to the point where the recovery really gets under way. That will require measures of a quite different nature and order of magnitude.

If monetary policy was really the key to recovery, we should surely have seen it by now. We have, after all, had falling and historically low interest rates for years now, and the economy has hardly stirred. As I and others argued in 2008 and 2009, using monetary policy as the only stimulus to an economy in a recession is like pushing on a piece of string.

The Governor has, in other words, done what he can, but what he can do is pitifully inadequate and beside the point. His recourse to involving the Minister of Finance last week suggests that he might be moving to this view as well.

No one doubts that our problems are endemic and that the Christchurch earthquake has added to the government’s difficulties. But the failure to take any decisive action over a couple of years means that the earthquake cannot be identified as the primary cause of our problems.

The government has in effect contented itself with trying to look after its own finances, and has been happy to let the wider economy look after itself. The paradox is that public finances are the healthiest part of our economy. Focusing primarily on getting the government’s deficit down, while ignoring the need for a whole-of-economy perspective, has reflected an ideological rather than practical priority, and has left the economy ill-equipped to grapple with its problems – among which, sadly, the consequences of the Christchurch earthquake now loom large.

Surely governments should be held to account for what they are elected for – providing an effective stewardship of the economy – and the Governor of Reserve Bank should no longer be abandoned to his lonely and irrelevant vigil?

As we begin the New Year with the hope of climbing out of recession, we are in danger of overlooking – or misunderstanding – one of the lessons we should have learnt from the global downturn. What the meltdown should have taught us is that economics, as Keynes insisted, is a behavioural science. It is not subject – like physics – to inexorable scientific laws, nor is it to be captured or foretold through mathematical formulae. Economics is the attempt to account for and predict how people – with all their foibles – will behave in response to the stimuli that economic circumstances provide to them.

Governments, and economic policy-makers, understand this, even if they say they don’t. Otherwise, they wouldn’t bother with changing those stimuli in the hope of improving economic performance. Even monetarists, whose basic attitude is that all governments can do is to hold the ring and let people get on with it, are keen interventionists when it comes to pushing this button or pulling that lever.

What we seem to have difficulty in grasping, however, is that the most powerful economic stimuli are those provided by macro-economic policy – the way in which we manage the economy as a whole. We insist on treating that as a given, beyond the reach of policy-makers to influence. “There is no alternative” we are told, either explicitly or implicitly; the ability of governments to influence economic developments is said to be limited to pushing or prodding at specific supposed pressure points. Even 25 years’ experience of the failure of such measures to raise our overall economic performance does not deter us from pushing on doggedly with new versions of old and usually failed remedies.

But this represents a total failure to understand Keynes’ basic insight. The most important economic function of government is to adjust the macro-economic context so that – in a market economy – the overall market and the response people make to it will do the job for us. If macro-economic policy settings allow the market to function efficiently, then much specific intervention will be rendered unnecessary.

Conversely, the less attention we pay to the macro-economy, the greater will be the apparent need and temptation to intervene with specific measures, in an attempt to make up for the deficiencies in economic performance that our macro policy – or lack of it – has made inevitable, and the greater will be the (repeated) disappointment when those measures prove ineffective.

The basic concerns of macro-economic policy should be the overall competitiveness and profitability of our productive sector. The focus should not be any particular firm or industry but the economy as a whole. If those concerns were properly addressed, our productive industry would – without specific intervention – help us to balance our current account, invest in new capabilities for the future, provide worthwhile job opportunities to the whole population, pay proper attention to sustainability, produce buoyant tax revenues to the public purse, and generally produce a more successful and easily managed economy and society.

So, set alongside these goals, how does our macro-economic policy shape up? Does it provide the stimuli that will produce the right responses?

Well, we begin by defining macro-economic policy virtually out of existence. We insist that it is really just a question of monetary policy, and monetary policy for a very limited purpose – the control of inflation. We pay no attention to other policy objectives like competitiveness, profitability or full employment. We have, in other words, fallen at the first hurdle.

We then engage the limited tools of monetary policy – principally interest rates but also exchange rates as an inevitable concomitant – to do a job they are not designed for. Instead of helping efficient market operations by providing market-clearing prices, interest rates and exchange rates are used to distort the market in the interests of controlling inflation – and not very well at that.

Macro-economic policy thereby becomes, not an instrument for promoting the overall economy, but a guarantee that it will not be allowed to prosper. If, by virtue of superhuman efforts by our farmers and manufacturers, or of strokes of good luck such as the rise in dairy prices, we manage briefly to improve our trading performance, the response of our policy-makers (with the help of the foreign exchange markets) is to stimulate a rise in the exchange rate which will wipe out any gain in profitability. And that is a problem because unless there is improved profitability which can be re-invested in productive capacity, there is no escape from our disappointing economic performance.

We insist, in other words, on delivering the message to our most dynamic producers that there is no point in investing in New Zealand’s productive capacity because our policy-makers have other priorities. The power of the overall market forces we set in motion as a result of our neglect of macro-economic policy is such that no amount of poking or prodding at small parts of the economy will have much effect. Little wonder that Kiwis conclude that housing is a better investment than productive capacity.

The stimuli our macro policy provides to our overall economy are, in other words, the very converse of what Keynes would recommend. It is time to recognise that the Keynesian approach offers not just the only way of escaping from recession (as is now reluctantly recognised by most commentators) but is also a long-term blueprint for the health of our economy. If we want a better economic performance, we need to think harder about the “behaviours” that our policies make inevitable.

Bryan Gould

29 December 2009

This article was published in the New Zealand Herald on 4 January 2010.